Regulators cast shadow over dubious loans
China’s economy has steadily become more debt-ridden. Governments, households, companies and institutions borrow money to make more money, but concern is mounting that it all may be at a tipping point.
The ratio of debt to gross domestic product has grown since the 2008 global financial crisis, prompting a shift in official policy to “bubble deflating,” according to Zhou Hao, a senior economist for emerging markets at Commerzbank.
The resulting brakes on debt accumulation have weighed heavily on the banking industry, which relies on lending for profits.
Where does that leave banks going into a new year?
Financial risk control is certain to remain a priority in 2018. It was listed among the “three tough battles” by the top decision-makers at the Central Economic Work Conference.
Regulators have proposed a slew of new regulations to fend off risk. In November, the People’s Bank of China drafted new rules for the asset management industry, aiming to reduce financial leveraging and arbitrage.
They prohibit managers in the 60 trillion yuan (US$ 9.3 trillion) asset management market from promising investors a guaranteed rate of return and stipulate that financial institutions must offer yields based on the net asset value of the products they are selling.
Against that backdrop, commercial banks have to make changes, said Wei Jiyao, an analyst at financial planning research firm PY Standard.
Parts of the asset management sector fall into the country’s “shadow banking” system, which has been largely unregulated.
Banks and regulators are now discussing the proposed new rules, and there may be some compromises, according to May Yan, head of China Financials at UBS investment research.
“After all, a sharp contraction in the shadow banking system might have a big impact on the economy,” she said. “The government needs to strike a balance.”
A reallocation of assets may benefit the insurance sector.
Kelvin Chu, director of Asian insurance and diversified financials at UBS, predicts that insurers will have “more space” to compete with banks in the realm of long-term asset management products.
The government’s determination to rein in runaway lending practices is beginning to bite.
The China Banking Regulatory Commission said in a statement last weekend that long-term efforts are needed to tackle “disorder and chaos” in the industry. Oversight of the shadow banking system and interbank activities sits at the top on its agenda.
In January, the watchdog published new measures to increase scrutiny over the shareholdings of commercial banks to rein in abuses related to major shareholders.
That was followed by a notice banning banks and other institutions from extending loans via entrusted loan accounts, a popular form of shadow banking.
Reducing debt will continue this year, but the pace may slow in the interest of keeping the market liquid, said Raymond Yeung, chief economist of China at Australia & New Zealand Bank.
Banks should stick to their core businesses and not get involved in the chaos that has marked sections of asset management, he added.
Robin Xing, Morgan Stanley's chief China economist, predicted that the central bank will raise interest rates on loans and deposits in the third quarter.
“The move would at least help divert people from investing in wealth management products and attract money back onto bank balance sheets,” he added.
Banks need to strengthen their capital bases via equity and bond issues to meet new regulatory requirements, said Commerzbank’s Zhou.
It’s a big challenge for banks to improve their liquidity management, according to Qu Tianshi, a markets economist at Australia & New Zealand Bank (China).
Previously, banks used to extend loans without enough consideration toward liabilities, he noted. Now they had better think twice about how to allocate assets.
He added that banks should return to their core function as “capital intermediaries.”
Looking ahead, Gao Ting, chief China strategist at UBS Securities, predicts that big state-owned lenders will outperform their mid-cap and smaller peers in terms of profitability.
“Liquidity tends to be tight in the market, which will push up interbank rates and thus the funding costs of smaller lenders,” he added.
Those lenders should concentrate on business aimed at smaller companies and on retail banking, industry observers said.
All the banks seem intent on increasing investment in information technologies, according to a recent survey by the China Banking Association and PricewaterhouseCoopers, an accounting and auditing firm.
China Industrial Bank, a mid-sized joint-stock lender, recently teamed up with Microsoft China to create smart banking capabilities.